Finally some possible good news: There may be a solution to the credit crisis caused by shaky subprime mortgages. Citigroup (NYSE: C) is leading the charge to piece together a pool of funds with other big banks that would financially back as much as $100 billion in shaky mortgage securities and other investments, according to the Wall Street Journal. Talks to work out this solution started three weeks ago at the U.S. Treasury Department, which is playing a crucial role in making this happen. Success in putting this fix together may be announced as early as Monday. Two other key players in these talks are Bank of America Corp. (NYSE: BAC) and J.P. Morgan Chase & Co. (NYSE: JPM), which don't have SIVs but would earn fees in helping to arrange the fix.
Citigroup CEO Chuck Prince is desperately trying to save his skin with this bailout, which is reminiscent of the bailout for Long Term Capital Management in 1998. What exactly is it that is being bailed out? They're called SIVs (structured investment vehicles). Essentially SIVs are short-term debt used to raise money to buy high-yielding assets, such as securities tied to mortgages or receivables (money due from customers of mid-size businesses).
Citigroup, which is the largest player in SIVs, holds nearly $100 billion in SIVs, and globally there are $400 billion in SIVs as of Aug. 28, according to Moody's. If the banks that hold them have to write them down, we haven't seen anything yet. There could be an even broader credit crunch, which would hurt the economy even more than the pain we already feel. In August, banks holding SIVs had difficulty rolling over their short-term debt, which seized up credit markets until the Fed stepped in and encouraged banks to borrow money by reducing the rate at which they could borrow it.
SIVs are held off the books -- sound like Enron? You're right. It was off-balance-sheet liabilities that played a major role in Enron's collapse. Banks keep SIVs off the books to reduce the amount of assets they must keep on hand according to federal regulations.
Who buys SIVs? Traditional buyers of SIVs include money-market funds, municipalities and other risk-adverse investors that like the high credit rating of SIVs. Until this mortgage mess, no one thought SIVs were a risky investment vehicle.
How will the fix work? According to the Wall Street Journal, Citigroup's plan is to create a "superconduit" fund that is backed by the world's biggest banks. This conduit would issue short-term debt and buy the assets currently held by SIVs affiliated with the participating banks. The banks involved in this creative fix hope that this new short-term debt would ease fears investors now have and encourage them to buy the bank's short-term debt or commercial paper.
Will it work? As an investor I certainly wouldn't get caught up in this bailout scheme, but there are folks out there willing to take the risk if the payoff is high enough.
Lita Epstein is the author of more than 20 books including the Complete Idiot's Guide to the Federal Reserve and The 250 Questions You Should Ask to Avoid Foreclosure.